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Operational risks are those of malfunctions of the information system, reporting systems, internal risk-monitoring rules and internal procedures designed to take timely corrective actions, or the compliance with internal risk policy rules. Operational risk could be defined as ‘the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events’. In the absence of efficient tracking and reporting of risks, some important risks remain ignored, do not trigger any corrective action and can result in disastrous consequences. In essence, operational risk is an ‘event risk’. There is a wide range of events potentially triggering losses.

The very first step for addressing operational risk is to set up a common classification of events that should serve as a receptacle for data gathering processes on event frequencies and costs. Such taxonomy is still flexible and industry standards will emerge in the future. What follows is a tentative classification. Operational risks appear at different levels:

People,

Processes,

Technical,

Information technology.

People risk designates human errors, lack of expertise and fraud, including lack of compliance with existing procedures and policies.

Process risk scope includes:

Inadequate procedures and controls for reporting, monitoring and decision-making.

Inadequate procedures on processing information, such as errors in booking transactions and failure to scrutinize legal documentation.

Organizational deficiencies.

Risk surveillance and excess limits: management deficiencies in risk monitoring, such as not providing the right incentives to report risks, or not abiding by the procedures and policies in force.

Errors in the recording process of transactions.

The technical deficiencies of the information system or the risk measures.

Technical risks relate to model errors, implementation and the absence of adequate tools for measuring risks.

Technology risks relate to deficiencies of the information system and system failure.

For operational risks, there are sources of historical data on various incidents and their costs, which serve to measure the number of incidents and the direct losses attached to such incidents. Beyond external statistics, other proxy sources on operational events are expert judgments, questioning local managers on possible events and what would be their implications, pooling data from similar institutions and insurance costs that should relate to event frequencies and costs.

The general principle for addressing operational risk measurement is to assess the likelihood and cost of adverse events. The practical difficulties lie in agreeing on a common classification of events and on the data gathering process, with several potential sources of event frequencies and costs. The data gathering phase is the first stage, followed by data analysis and statistical techniques. They help in finding correlations and drivers of risks. For example, business volume might make some events more frequent, while others depend on different factors. The process ends up with some estimate of worst-case losses due to event risks.

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October 2015 - Fabrici Management Consulting has signed a Contract to deliver Enterprise Application Integration for Transpetrol, a.s.